Setting and achieving savings goals
No matter whether you want to make your dreams come true, build wealth or protect yourself against unforeseen events – if you can set some money aside, you will live a life with fewer financial worries.
Strategic saving
Saving money does not mean that you cannot buy anything that you would like to have. However, you need a goal and a plan for how much you can and want to save. Otherwise, it can be frustrating when you think about saving at the end of the month and then feel guilty because you have, once again, not reached your savings goal. It is a good strategy to plan your savings at the beginning of the month. For example, you can put aside a certain amount every month and set up a standing order to transfer money from your current account to a savings product (there are lots of different products to choose from).
If you save regularly over an extended period of time, the savings can add up to a considerable amount of money. Even if you save small amounts, you can still build wealth by using the right strategy and various savings and investment products.
Tip
- Depending on your personal situation, you should keep a financial reserve equivalent to three to six months of net income.
Interest
If you decide not to put all your money in a piggy bank and a current account but transfer it to a savings account, you can put it to work and make your money grow. This is because that money earns you Interest. which is important because your money loses its value due to inflation. By choosing a suitable savings product, you can reduce or completely avoid this loss in purchasing power.
Interest is the price for borrowing or investing money over a certain period of time. The interest that savers receive when they deposit money in a bank is determined by the savings interest rate (Deposit rate). This means that the Return on the money saved is a function of this interest rate. Like any investment income, interest is subject to Investment income tax (KESt). The bank withholds the tax and transfers it directly to the tax office.
The amount of interest earned is determined by the size of the deposit, the general level of interest rates, and by the maturity and the type of savings product (see below). The more money you put in a savings product, the more interest you will earn. When the general level of interest rates is low, deposit rates will also be low. When interest rates are elevated, deposit rates are likely to rise as well.
Deposit rates are determined by the general level of interest rates, for example by the three-month EURIBOR (see chart below). Interest rates, in turn, are driven by the key interest rates set by the Eurpoean Central Bank (ECB). The maturity of the savings product is another factor influencing the deposit rate that banks offer. Longer-term savings products usually have higher interest rates than savings products where the money can be withdrawn at any time.
Tip
- Banks respond to changes in interest rates very quickly. For this reason, you should review interest rates before deciding to put your money in a savings product. This might allow to you to negotiate a better interest rate. Even after making the decision, you should monitor interest rates regularly.
Interest rates are often quoted as a percentage with p. a. being added. This refers to an annual interest rate (from Latin: per annum). The following applies (in Austria): In the context of savings accounts, a month has 30 days, and a year has 360 days.
The interest rate can be locked in for a specific period of time. This means that the interest rate will not change even if the general level of interest rate goes up or down.
Example: Savings product with a variable interest rate: 3.25% p.a.
Deposit: EUR 10,000
Term: 1 year
Final savings: EUR 10,300
Interest: 10,000 *3/ 100 = EUR 300
If you choose a variable interest rate (Interest escalation clause), your interest rate will periodically adjust based on a reference rate. The adjustment frequency is determined by the length of the period during which the reference rate applies after each adjustment. The reference rate reflects the general level of interest rates.
Example: Savings product with a variable interest rate: 3.25% p.a.
Deposit: EUR 10,000
Term: 1 year
Case 1: No change in the key interest rate à No adjustment
Final savings: EUR 10,325
Interest: EUR 10,000 * 3.25 / 100 = EUR 325
Case 2: Key interest rate goes up à After six months, the interest rate rises to 3.75% p.a.
Final savings: EUR 10,350
Interest: EUR 10,000 * 3.25 / 100 * 0.5 years + EUR 10,000 * 3.75 / 100 * 0.5 years = EUR 162.50 + EUR 187.50 = EUR 350
Case 3: Key interest rate goes down à After six months, the interest rate falls to 2.5% p.a.
Final savings: EUR 10,287.50
Interest: EUR 10,000 * 3.25 / 100 * 0.5 years + EUR 10,000 * 2.5 / 100 * 0.5 years = EUR 162.50 EUR + EUR 125 = EUR 287.5
At first glance, the variable-rate savings product seems to be more attractive than the fixed-rate savings product. However, it is only at maturity that you can tell which product has actually yielded a higher return.
Example: Deposit rate = three-month EURIBOR.
This means that the interest rate is adjusted every three months.
Deposit: EUR 10,000
The EUR 287.50 in interest income is subject to investment income tax, which comes to EUR 287.50 x 25% = EUR 71.88.
The Nominal interest rate is the interest rate of a financial product or investment. It indicates the amount of interest you receive on the capital you have invested. Savings product usually state an annual interest rate (e.g. 3.25% p.a.). With annual interest payments, this means that after one year, you will receive EUR 3.25 in interest on a deposit of EUR 100.
However, the nominal interest rate does not always correspond to the actual rate of return. If you have to pay costs or fees, the return will be lower than the nominal interest rate.
Tip
- To compare savings products, you need to determine the return for each product. In addition to the interest rate, you need to take into account all other additional costs and fees.
Compound interest: What is it and what can it do for you?
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Compound interest
Compound interest occurs when you do not withdraw your interest payments and keep that money invested. As a result, your capital increases each year as a result of the accumulated interest payments, which will also earn interest in subsequent years. This capital growth is referred to as compound interest and its effect is particularly powerful in long-term investments.
Example
Michael and Lanea have both saved EUR 1,000. They put that money in savings accounts with an annual interest rate of 5%. After one year, they both receive EUR 50 in interest and their savings account balance is EUR 1,050. Lanea keeps all the money in her savings account, while Michael withdraws the interest payments every year.
In the second year, Michael and Lanea start to see the effect of compound interest. Michael receives another EUR 50 in interest (5% of EUR 1,000), which he withdraws again. Lanea gets EUR 52.50 in interest (5% of EUR 1,050), which she reinvests.
After 10 years, the situation is as follows:
Michael receives EUR 50 in interest every year, which means that after ten years he has received a total of EUR 500 in interest (10 * EUR 50).
Lanea grew her capital by reinvesting the interest earned and keeping it in her savings account. After ten years, she has received EUR 628.89 in interest and has saved a total of EUR 1,628.89, as the capital invested and the interest earned produce compound interest. As a result, her capital has grown considerably.
The longer you can put your money to work and grow it, the bigger the difference will be.
After 25 years, Lanea's capital has more than tripled due to compound interest. She has received a total of EUR 2,286 in interest and compound interest (EUR 1,000 * 1.05^25 = EUR 3,386.35 – EUR 1,000 = EUR 2,386.35 ~ EUR 2,386), while Michael, who withdrew the interest income from his savings account every year, has only received EUR 1,250 in interest (EUR 50 * 25 years = EUR 1,250).
Example
Lanea puts EUR 1,000 in a savings product with an interest rate of 5%. In contrast to the previous example, interest is compounded on a monthly basis. After ten years, Lanea has a balance of EUR 1,647, which is more than she would have received with annual compounding. After 25 years, Lanea’s EUR 1,000 deposit has grown to EUR 3,481.
Savings products
Wage and salaries are usually paid into a current account. As current accounts pay barely any interest on credit balances, it is advisable that you transfer the money (apart from an emergency fund) to higher-yielding savings products. What savings product is best for your personal savings goals? That depends on your individual needs. A good method is to have three accounts:
- A current account for your payment transactions
- An overnight deposit as an emergency fund
- Amounts in excess of this can be put in savings accounts, term deposits and similar products that lock in your money for a period of time and therefore pay higher interest rates
Tip
- Depending on your personal situation, you should keep a financial reserve equivalent to three to six months of net income. The specific amount will be determined by personal factors such as your family and housing situation (whether you rent or own your home). A financial reserve can be used to pay for unexpected expenses such as repairs and medical bills. Overnight deposits are the best choice for this, as they are safe, and the money can be accessed quickly.
Any money that is not needed as a financial reserve should be put in savings and investment products that produce higher returns.
When choosing a savings product, it is crucial to select the right product to get the best terms and conditions and returns. It is important to compare a number of different products to select the savings product that best suits your individual needs and investment goals. It is advisable to choose a product that fits your savings and sustainability preferences.
In addition to conventional products, banks also offer sustainable current and savings accounts. With these products, the bank undertakes to invest customer deposits in sustainable projects. When looking for sustainable bank products, the Austrian Ecolabel of the Federal Ministry for Climate Action (BMK) can provide you with guidance. This label is only awarded to financial products and banks that comply with the sustainability criteria, as verified by an independent body.
Savings books
A savings book is a traditional form of putting your money in a bank. It is issued as a savings document that takes the form of a book, and is used to record transactions such as deposits, withdrawals and interest payments.
People wishing to open a new savings book have to produce a valid ID as proof of identity. If the balance exceeds EUR 15,000, the savings book has to be in the name of the depositor. If the balance is lower, you can also create a password savings book. Savings books that are in the name of the person identified by ID offer more security. Only this person is able to withdraw money. Password savings books require that a password be set, which must be correctly provided at each withdrawal. No withdrawals can be made without the password. In many cases, however, banks only open savings books in the name of the depositor, even for balances below EUR 15,000. However, if someone else knows the password, this may cause security risks in the event of theft or loss. Savings book deposits are considered very safe because the depositor is protected by deposit guarantee schemes (up to a total of EUR 100,000 per person and bank). However, interest rates on savings books, and therefore returns, are low.
Savings account
Banks offer savings accounts as an alternative to the traditional savings book. These accounts are always in the customer's name and are managed by means of online banking. This means that the customer can carry out transfers between their current account (often referred to as the reference account) and their savings account on their own. In addition, savings accounts often come with bank cards that customers can use to make deposits and withdrawals at ATMs in bank branches. This makes it possible to carry out transactions outside of banking hours, which increases flexibility.
Savings accounts are available with different maturities and interest rates. As for risk and returns, savings accounts have the same characteristics as savings books.
Overnight deposits
With overnight deposits, you invest a certain amount of money at a variable interest rate for an undetermined period of time. A variable interest rate means that the bank can adjust the interest rate at any time. Overnight deposits give you quick access to your money and are particularly suitable for keeping a financial reserve. Unlike current accounts, overnight deposits cannot be used for making payment transactions. Instead, they are a short-term investment. Overnight deposits are particularly suitable for keeping a financial reserve as you can access the money at any time.
Note that some banks offer new customers an initial fixed interest rate on overnight deposits. This means that the bank guarantees a fixed interest rate for a certain period of time, such as six months. After this period, the interest rate will usually be adjusted to the general level of interest rates and potentially reduced. Overnight deposit interest rates can therefore end up being lower than rates on other savings products.
Term deposits
With a term deposit, you make a one-off investment for a fixed term at a fixed interest rate. The money is not available during the term of the deposit and will be repaid with interest at maturity. Term deposits normally pay higher interest rates than savings account and overnight deposits that can be accessed at any time. Term deposits can have terms ranging from a few months to several years. In contrast to overnight deposits, the interest rate remains constant for the entire term of the deposit. Term deposits are therefore a safe investment with predictable interest rates and maturities. They are suitable for medium-term investment.
Note that early withdrawals from term deposits can come with high costs, as is the case with fixed-term savings accounts. If you need to access your term deposit before maturity, your bank may reduce your interest rate and apply penalty fees.
Building savings and loan contracts
A building savings and loan contract is a government-subsidized type of savings product that is subject to special rules. Although the returns tend to be low compared to other investments, building savings and loan contracts are considered a safe and easy-to-manage investment. The term is usually six years, and regular deposits are made during that time, accumulating savings. There are various building societies that offer products with fixed, variable and a combination of fixed and variable interest rates.
In addition to interest payments, customers also receive a government subsidy called a building society bonus, which is exempt from investment income tax. The amount of the government bonus is set annually by Austria’s Federal Ministry of Finance. The annual deposits under the building savings and loan contract are supplemented by the bonus. However, in the event of early termination of the building savings and loan contract, the government bonus will have to be repaid.
Tip
- With savings products, it is not just the basic terms and conditions that are important. Pay particular attention to special offers as you might be offered a fixed interest initially and a variable interest rate afterward. Additional fees can also significantly reduce your interest income. It is therefore important to read the terms and conditions carefully and watch out for any fees.
Deposit rates and inflation
It is important that you monitor interest rates and inflation and make your investments based on your observations. Depending on your investment horizon and in response to potential changes in interest rates, certain types of savings may tend to be more profitable, especially when interest rates are going up and inflation rates are changing.
The Real interest rate measures the actual return on a financial investment. It is determined not only by the deposit rate (i.e. the nominal interest rate), but also by the decline in Purchasing power caused by Inflation.
The real interest rate can be approximated using this formula:
[Nominal interest rate] – [inflation rate] = [real interest rate]
At an Inflation rate of 0%, the real interest rate is equal to the nominal interest rate. If the inflation rate is higher than the nominal interest rate of an investment, the real interest rate is negative, i.e. the investment is losing money.
Example
Tim pays EUR 500 in a savings account with a nominal interest rate of 3% p.a. After one year, he receives EUR 15 in interest and therefore has a balance of EUR 515. However, if inflation runs at 5% during this period, Tim needs EUR 525 to buy the same goods and services that his EUR 500 would have bought a year ago. In our example, the real interest rate is therefore –2%.
3.0% – 5.0% = –2.0%
This loss of purchasing power is exacerbated by the investment income tax:
Nominal interest rate = 3% of EUR 500 = EUR 15
Investment income tax: = 25% of EUR 15 = EUR 3.75
EUR 15 (interest) – EUR 3.75 (investment income tax) = EUR 11.25 (interest after tax)
After deduction of the investment income tax, Tim receives EUR 11.25 in net interest.
25% investment income tax on 3% interest = 0.75%; 3% – 0.75%= 2.25%
2.25% – 5% = – 2.75%
Despite recent increases, interest rates remain well below the inflation rate, which means that low-return savings products have negative real interest rates. These low-risk ways of saving therefore entail a Loss of purchasing power. They are not suitable for building long-term wealth but can be used to achieve short and medium-term savings goals. To limit the loss of purchasing power, you should regularly compare various savings and investment products.
Given the current inflation rate and the relatively low level of interest rates, the average real interest rate on overnight and term deposits remains negative. This means that your savings are losing their purchasing power. In order to build wealth with small amounts of money, you need to put your money in more profitable investment products, rather than just traditional savings products.
A brief recap
Why you should not save your money at home?
If you put your money in a savings product, it will earn interest, but if you keep your money at home, it will not. Your interest income will be determined by a number of factors, i.e. the size of your deposit, the general level of interest rates, the type of savings product and its maturity.
What savings options exist
A good way to organize your personal finances is to split your money between three accounts. A current account for payment transactions, an overnight deposit for a financial reserve and another account such as a term deposit for any money not needed in the former two accounts. It makes sense to set a fixed amount that you want to save and to have it automatically transferred to a savings product at the beginning of the month.
How do sustainable current and savings accounts differ from conventional products?
In addition to conventional products, banks also offer sustainable current and savings accounts, which means that the bank undertakes to invest the deposits in sustainable projects.
How can I find the savings product with the best return?
When choosing a savings product, it is crucial to find the right product for the best returns and terms and conditions. By comparing a number of different products, you can choose the one that suits your individual needs and goals. It is advisable to select a product that fits your savings behavior and individual sustainability preferences.
What is compound interest?
Compound interest helps grow your capital provided that you reinvest the interest earned instead of withdrawing it. As a result, your capital will grow because of the interest earned, which will also earn interest in later periods. This effect is particularly powerful in long-term investments. Currently, inflation is high while interest rates are (relatively) low, which means that real interest rates on overnight and term deposits are negative. This means that the money invested loses its value in real terms. To build wealth, it is therefore necessary to invest in higher-return investment products, and not just savings products.
Why are savings products not always a good choice to build wealth?
During periods of elevated inflation rates and low interest rates, average real interest rates on overnight and term deposits are negative. This means that your savings lose their value in real terms. To build wealth with small amounts of money, you need to invest in higher-yielding investment products, not just in conventional savings products.